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Unofficial Survey - Commercial Real Estate Markets

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jimstein

Thread Starter
Freshman Member
Joined
Jan 6, 2006
Professional Status
Certified General Appraiser
State
California
I've been appraising commercial properties in Southern California since 1991, thus I cut my teeth in the industry during the last downturn. While my observations are specific to Southern California markets, feel free to answer, based on your observations and perceptions of your own market.

I have long thought that if residential markets tank, commercial markets will follow. Thus, I find myself waiting for the other shoe to drop. That said, there is little to no evidence of an impending decline visible at the moment. Then again, the same could have been said in June of 1990. For the most part, Cap Rates haven't changed in the last year and asking rents for all property types continue to rise.

Nonetheless, vacancy for all property types, but especially office, have been inching up and absorption has been negative for the last two quarters. CMBS(s) are DOA for now. As a result, banks have far less liquidity and hard money lenders, along with their typically higher cost of funds, appear to be filling the gap. Add to the above all the inherent troubles in residential markets and all their current and future effects on the economy.

Given the above observations, and of course your own, do you believe that there is more risk to commercial real estate markets today than a year ago? If so, how are you accounting for it? If not, what are the factors in the market that you think will protect it from downturn?

I am sincerely interested in your answers. Personally, I am of the view that the patient is on life support, it's heart is still beating, but the brain is dead. If you think I'm totally missing something, please feel free say so!
 

rbrienza

Member
Joined
Sep 16, 2007
Professional Status
Certified General Appraiser
State
Colorado
Jim,

I can tell you that our firm is very busy. We do strictly commerical properties. Most of the other commerical appraisers that I talk to are busy also. So, if the commercial market is going to fall.... I don't see it until late next year.

How are the markets in So Calfi? My paraents live in San Diego/ Coronado.

Ray
 

Vernon Martin

Senior Member
Joined
Jun 8, 2005
Professional Status
Certified General Appraiser
State
California
Jim,

As a commercial appraiser in SoCal, my observations are similar to yours.

Most of my work is in residential subdivisions, and this part of the market has already depreciated significantly, but subdivisions don't really qualify as commercial properties.

I also see high occupancy and low cap rates at the local income-producing properties. I've been appraising here since 1985, and I remember the last commercial downturn very well as it lagged a couple years after the residential market downturn. The last commercial downturn was induced by oversupply. I don't see such oversupply this time.

I think that larger commercial properties are already being repriced lower, though, as the result of nervousness in the CMBS markets. Even the holders of the highest rated securities are asking for higher returns now as investors lose their confidence in the agency ratings (Moody's, etc.).

Smaller commercial properties still seem to enjoy a seller's market, as the pool of investors are typically moms and pops rather than Wall Street. Everybody still wants to have a rental property for the time being. A 55-year-old 1800 sf office building will still sell at a 5.5% cap rate, partly due to investor demand and partly due to increasing commercial land values. The shortage of available commercial land in the developed areas seems to insulate this market.

Neverthless, I see forces at work to increase risk in the local commercial market, as follows:

1. More conservative loan underwriting. Higher LTV ratios will be required, thus reducing the pool of eligible buyers. Propety owners with balloon payments coming up might find that they don't have enough equity to refinance, too, thus resulting in "Maturity defaults" and possible foreclosure.

2. The enormous overhang of debt. At today's low cap rates, I suspect that many properties were purchased with negative cash flow in the initial years, with the expectation that rents and property values would go up. When the appreciation stops, some property owners might give up and walk away from their properties.

I would expect retail and multi-family properties to be the first to decline in value.

Collection problems are already increasing for apartment owners, and some areas, such as downtown San Diego, are developing surpluses of new condos which may end up competing with rental apartments.

Retail properties typically suffer in a recession, and I think a recession is likely.
 

PL1957

Senior Member
Joined
Jul 19, 2004
Professional Status
Certified General Appraiser
State
Illinois
I've been appraising commercial properties in Southern California since 1991, thus I cut my teeth in the industry during the last downturn. While my observations are specific to Southern California markets, feel free to answer, based on your observations and perceptions of your own market.

I have long thought that if residential markets tank, commercial markets will follow. Thus, I find myself waiting for the other shoe to drop. That said, there is little to no evidence of an impending decline visible at the moment. Then again, the same could have been said in June of 1990. For the most part, Cap Rates haven't changed in the last year and asking rents for all property types continue to rise.

Nonetheless, vacancy for all property types, but especially office, have been inching up and absorption has been negative for the last two quarters. CMBS(s) are DOA for now. As a result, banks have far less liquidity and hard money lenders, along with their typically higher cost of funds, appear to be filling the gap. Add to the above all the inherent troubles in residential markets and all their current and future effects on the economy.

Given the above observations, and of course your own, do you believe that there is more risk to commercial real estate markets today than a year ago? If so, how are you accounting for it? If not, what are the factors in the market that you think will protect it from downturn?

I am sincerely interested in your answers. Personally, I am of the view that the patient is on life support, it's heart is still beating, but the brain is dead. If you think I'm totally missing something, please feel free say so!
I think you are missing something. If you simply look at year end vacancy rates, most commercial markets are strong (with the exception of residential subdivisions and condos). CBRE reports year end 2007 industrial vacancy at 10.2%, slightly higher than the 9.7% reported at year end 2006, but well below the 11.5% rate reported at year end 2002. Office numbers are similar at 12.8% (4Q2007), 12.6% (4Q2007) and 15.6% (4Q2002). Granted, these are national numbers and may not reflect your individual marlet's performance.

The difference between now and then is that in the late 1980's and early 1990's, we had a real estate crisis. Buildings were built for no apparent reason and "see through" buildings were common. The 2000's real estate market has been extremely disciplined, with little or no overbuilding occurring, except in the residential sector. This residential sector is what is in serious trouble.

IMO, the current crisis is NOT a real estate crisis, but a liquidity crisis. The temporary death of the CMBS market (and yes, I do think it will come back eventually) has had a significant effect on liquidity. But even at its peak, CMBS represented only 25-30% of all commercial lending. The remaining 70-75% is still there. From what I've seen, the credit crunch has primarily affected the two extremes of the commercial lending arena - the huge, mega-loans which just can't be placed (see Centro and Macklowe) and the loans that were truly marginal to begin with and probably shouldn't have been done in any market (see IO's). The stuff within one standard deviation of the bell curve is still there, is still being funded, and is chugging along.
 

Kali the Boston Terrier

Senior Member
Joined
Jul 7, 2003
Professional Status
Certified General Appraiser
State
Michigan
How are we confusing how busy we are with the strength of the real estate market. I have been busy for 5 years straight with little break, yet 95% of my work is foreclosure, litigation, and estate planning. So is the health of my market based upon how busy I am? Then by that standard Detroit is doing really well, in fact better than last year...it only gets better.

Ok enough of the sarcasm...

In our market residential started tanking about the middle of 2005, it took till about the latter part of 2006 and beginning of 2007 before I started to see rental rates starting to drop on things beside industrial. After that time we saw office and retail rates starting to drop. At no point did cap rate start to show increases whent he rental rates started to drop. It wasn't until mid 2007 when rental rates decreases were part of the conventional wisdom of buyers, sellers, tenants and brokers before cap rates started to edge up.

So the short answer is that for us it was about 2 years of tanking before the stickiness of commercial prices started to fall after the commercial. Really I think the main cause behind this is that lease terms tend to be negotiated on 3 and 5 year terms around here, so prices are sticky in the context of lease agreements. So what we started seeing in 2007 were lease negotiated between 2002 - 2004 being up, and either not be renewed, firms exitng the business or renegotiated downward. At least that's what I see.
 

Kevin Kent

Sophomore Member
Joined
Jul 12, 2006
Professional Status
Appraiser Trainee
State
Virginia
My firm works in LIHTC multifamily residential. Given the fact that big corporate purchasers of tax credits have been hurting, our work should be down. However, our work (mostly new construction and rehab) is up for the first 2 months of 2008 over the first 2 months of 2007. Our work is 100% national. We have no regional market.
 
Joined
Jan 13, 2002
Professional Status
Retired Appraiser
State
Florida
I'm watching the vacancy rate in the commercial properties in my area and it continues to scare me as much or more than the residential here. We have some large industrial vacancies, but we have a growing number of retail vacancies while some are still building more. Some of these places have been vacant and for sale or for rent/lease for more than a year +++, and more are being built???

Question for you CGs:

Are demographics forecasting for retail and professional offices based on residential building permits??? If so, that really skewed reality in the areas where the speculator flipping of new houses caused the building of residential properties to expand much larger than the real population growth.

I keep thinking that if I could see this coming for so long, why couldn't others? Isn't continuing to build when there is no apparent market for the product and a growing number of existing competing product available at declining prices throwing good money away?
 

PropertyEconomics

Elite Member
Joined
Jun 19, 2007
Professional Status
Certified General Appraiser
State
New Mexico
I'm watching the vacancy rate in the commercial properties in my area and it continues to scare me as much or more than the residential here. We have some large industrial vacancies, but we have a growing number of retail vacancies while some are still building more. Some of these places have been vacant and for sale or for rent/lease for more than a year +++, and more are being built???

Question for you CGs:

Are demographics forecasting for retail and professional offices based on residential building permits??? If so, that really skewed reality in the areas where the speculator flipping of new houses caused the building of residential properties to expand much larger than the real population growth.

I keep thinking that if I could see this coming for so long, why couldn't others? Isn't continuing to build when there is no apparent market for the product and a growing number of existing competing product available at declining prices throwing good money away?

Pam,
I would think residential building permits are only part of the equation with much more emphasis placed on population growth. Many projects are on the drawing board for two years prior to their construction and then given a year or more of construction time it is sometimes difficult to pull the decision to build because of the amounts of monies already invested. I would suggest that while many may have seen foreclosure rates potentially climbing, not many saw the extreme credit crisis and lack of liquidity as being overly possible. Much of this crisis has been built on isolated spots in the country which have been so heavily reported in the media that it resulted in a national crisis. While we all saw the potential for troubles, I dont think any of us forsaw what has actually happened, and the commercial / industrial investors are no different in my mind.
I always thought the extremely low cap rates were nuts and continune to think so. Residential building permits are down considerably in my market and yet we have one of the lowest foreclosure rates in the country. I truly think my market suffers more from media exposure of the crisis than from the crisis itself.
Perhaps this doesnt answer your question fully, but I believe the commercial developers thought the crisis in the housing sector would be short lived and contained to certain markets. Obviously that has not been the case.
 

Artyman1200

Sophomore Member
Joined
Jun 21, 2004
Professional Status
Certified General Appraiser
State
Tennessee
We have several new small retail centers (6-10 units) in Knoxville that have been completed within the last year that are still 100% vacant. It's not like the tenant finishes are in the process of being completed, they're just sitting there.

Also, I've noticed pretty solid properties for sale on the MLS that I haven't seen over the last couple years. Good quality properties that are 100% leased with cap rates from 6% - 8%. I haven't seen properties like this on the MLS in a while. Of course, commercial MLS listings are usually overpriced, but it seems like owners think that now is the time to sell.
 

Lost Cause

Senior Member
Joined
Sep 17, 2004
Professional Status
Certified General Appraiser
State
New York
Of course all these markets are interrelated. Problems in one segment of the real estate markets may not always reverberate in other segments. Nevertheless, with the liklihood of a serious recession high, I don't doubt that all real estate markets will be impacted.

Now that many residential markets are troubled, I see retail as next to feel the pain. The credit crunch has impacted consumer spending and we have seen continued dismal retail results for some time now. I can't see any relief in the near term as the refinance ATM has been closed for a few months now.

That said, the office market in NYC is currently very strong, regularly setting new record high sale prices and rents. It's not likely to last much longer, and I give it six to twelve months before serious deterioration sets in. Because there has been some discipline in this market, I would expect the impact to be in the form of stagnation rather the kind of free fall seen in the more speculative residential markets.
 
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